96-month car loans wreck your wallet

Want to be buried in debt? Take out an 8-year car loan

Don’t be tempted to jump on one of those 75- to 96-month auto loans. Even if it shaves a few bucks off your monthly budget, it could be one of the worst financial decisions you’ll ever make.

“You will be under water on your loan almost as soon as you drive the car off the lot,” says Alec Gutierrez, senior market analyst for Kelley Blue Book. “The longer you extend your terms, the longer it’s going to take to come to a break-even position on your loan.”

Auto lenders have been stretching loan terms due to record high prices. Competition among lenders, even for average to subprime borrowers, is also pushing lenders to offer longer terms. The average new-car loan now is at 65 months, a duration previously unheard of, according to Experian Automotive, an arm of the credit-monitoring and research company. Such loans represented some 17% of new-car loans, the company says, up from 11% in 2009.

More eye-opening is that financing for new cars with terms from 73 months to 84 months — that’s six- and seven-year-plus notes — jumped 19.4% in the fourth quarter of 2012 over the year-ago period. These longer-term loans may be good for household budgets now, but when it’s time to get behind the wheel of a new car, the loan amount left is likely to be greater than the trade-in value. That’s a negative-equity position that could put consumers in a vicious cycle of mounting car payments.

The average age of cars on the road is 11 years, making it seem like an eight-year loan would still leave a few good years left on the car without payments. But by that time, your old automobile will be incredibly difficult to unload at any semblance of a price that can justify all those monthly payments.

Let’s dissect the math. New-car price tags have reached, on average, a whopping $31,000, about $3,000 more than they were just five years ago. If you take out a five-year loan — that’s 60 months — and your credit is at an above-average level, not a subprime level, you’re likely to pay the national going rate of about 2.5% interest on the loan. (Subprime borrowers will face high single- and low double-digits rates, despite this low-interest rate environment.)

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Say your down payment is enough to cover the tax, title and license, or in the ballpark of 10% over the total purchase price. That brings the loan value down to about $27,900. Your monthly payment comes out to a little more than $495.

Over the course of the loan, however, you would pay about $1,810 in interest charges, upping the final purchase price to $32,810 for what will be, well, a five-year-old car when you’re finished paying off the loan.

Let’s stretch that loan period out another year, putting it into a 72-month cycle. Because the period is longer, the lender will attach a higher interest rate to cover the risk. Gutierrez estimates it will go to 3.5% for consumers with excellent credit. That will pull your monthly nut down to about $430 but the interest charges will jump to $3,072, upping the total cost for a car that will then be six years old to $34,072.

Adding just one extra year with the higher interest rate tacks on almost $1,300 to the final price.

“You’re lowering the monthly payment at the expense of increasing the overall costs to own that vehicle,” says Gutierrez.

Think that’s bad, here’s what happens when that loan period gets lengthened to 96 months, or eight years. The interest rates gets hiked again, and let’s be nice and say to 5% for those with good credit, and the monthly outlay drops to what for most would be considered a very affordable $353.

That might calculate well on a monthly budget, but over those eight long years, you’d be paying out a jaw-dropping $6,000 in interest. That’s more than a quarter of the total value of the loan and what you have left is a car that is most likely ready to go to pasture.

These scenarios, of course, only cover the costs of the loan. What if there’s a major accident or even a few unsightly dings and dents in the fender? The repairs will cost you, as will the upkeep on the car’s interior, not to mention under the hood, if you have any intention of selling it or trading it in.

“It’s silly to do something like a 96-month loan or even a 72-month loan,” Gutierrez says, though he tempers it with judicious comments about those who do keep their cars for 11 years.

“At the end of the day, if it’s only a few hundred dollars, then that might work for you,” he says. “But if it’s $1,000 or more, you should consider if that money can be better spent elsewhere.”

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